A Strong Currency Does not Ruin An Economy

One of my favorite myths pervading in the economics discussion is the idea that a strong currency must be avoided due to the fact it destroys exports by making them uncompetitive. You’ll hear this mantra repeated constantly in mainstream outlets, but the rationale is faulty. Focusing only on one group of actors in the economy over the short run in this manner leads to policy prescriptions that do not benefit the economy as a whole over the long run.

Switzerland released trade data earlier today, and exports declined compared with this month last year. This will give purchase to the mainstream view that a strong currency compromises export driven growth and is ruinous to the economy. This is only part of the picture however. Also released today was the UBS consumption indicator, which rose last month. Reactions to that data point present a less disastrous view of the Swiss prospects than do your standard response to the export data:

“The strength suggests that the economy may be supported by domestic demand,” said Informa Global Markets analyst Nikola Stephan. “Unemployment remains at low levels and low interest rates also fuel the spending mood.”

Prices of imported goods eased 2.2 percent in March, the trade data showed. Export prices were unchanged.

This was the UBS indicator’s strongest reading since July 2011, and the UBS economists said the real level of consumption might have been even stronger, because of high levels of immigration and an increase in consumer purchasing power due to falling prices.

Critics of strong currencies point to the fact that a stronger currency makes it more expensive for foreigners to buy the products produced by exporters. While this is true in the short term, it ignores the fact that the strong currency also serves to cheapen imports and input costs. Over the long term, exporters can alleviate the impacts of a strong domestic currency by lowering prices in nominal terms and increasing the volume of sales, something it can do given the drop in input costs that also come with a strong currency. This is the phenomenon behind the recent growth in Swiss watch exports. In short, strengthening currencies force exporters to constantly remain efficient.

The strengthening currency not only reduces costs for exporters, but for anyone holding the strong currency in question. With the Swiss, this is reflected in the higher purchasing power enjoyed by its citizens as prices have fallen. According to your standard views, the price level dropping is meant to be ruinous, leading to ‘deflationary spirals’ and what not. This simply hasn’t occurred. Rather the rising currency has enabled the Swiss to increase consumption, and increase their imported goods.

Returning to exporters, the rising Swiss Franc is not a new phenomenon. It has been a constant for years. The Swiss National Bank instituted a currency peg to the Euro, the currency of its largest trading partner, at 1.20 EUR/CHF, a level that is still higher in CHF terms than it was a year ago, roughly at 1.30. In 2007, the CHF was at its weakest point against the Euro, at roughly EUR/CHF 1.67. Against the dollar, the CHF has strengthened from a USD/CHF of 1.8 in 2001 to a level of 0.91 today. This constant strengthening since then has not prevented the Swiss export machine from functioning in any way.

Exports have risen throughout the period, with an understandable blip in 2008 for the financial crisis. Similarly, the resurgence of the Eurozone debt crisis has probably weighed just as much on exports as the strong franc has in the short term, but as the above graph shows, the export figures are hardly troubling in comparison to its long term trends. The benefits of the strong currency are thus shared by everyone, exporters, importers and consumers alike.

Swiss exporters are adjusting to that impending stagnation in the Eurozone by selling products to emerging economies, such as China, as shown below.

To conclude, a strong currency doesn’t destroy an economy. It merely results in various actors adjusting their spending patterns, in response to the new price levels. Contrary to popular belief, exporters do not suffer in the long run, as the relative difficulty in selling goods overseas is offset by the decrease in input costs. Any holder of the strong currency receives a benefit in the way of increased purchasing power, allowing for an increased standard of living.

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